Evergrande: What would China’s biggest debt restructuring look like?

Chinese property group Evergrande offered a glimmer of hope on Wednesday by announcing it had “resolved” interest payments for onshore bonds due this week, days after a debt crisis at the group rippled across global markets.

But the world’s most indebted developer did not say when it would make the payment and, most crucially, failed to shed any further light on an important deadline it faces on Thursday for its international bonds.

The developments have only added to uncertainty over the prospects of a default at Evergrande, an event that could spark the biggest debt restructuring in China’s history.

Anticipated for years because of its vast debts, a restructuring at Evergrande would still be a striking turnround for a company whose rapid growth made its chair and founder Hui Ka Yan China’s richest man as recently as 2017.

It would also be politically sensitive, given that tens of thousands of ordinary citizens hold the company’s investments, have bought its homes and invested in its related businesses.

What does Evergrande own and what does it owe?

Evergrande’s total balance sheet is about Rmb2.38bn ($368bn), as of the end of June. Its business mainly involves buying land from local governments, developing it and selling residential apartments to customers before construction is finished. The company uses the proceeds of those sales along with debt to finance further land purchases.

Evergrande has 778 projects in progress across 223 Chinese cities as well as stakes in businesses ranging from an electric vehicle maker to a bottled water company.

Its 214m sq m of land reserves in China were originally worth Rmb457bn, with more than two-thirds in first- and second-tier cities. The company had just Rmb87bn in cash as of the end of June. 

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As with its assets, Evergrande’s Rmb1.97tn ($305bn) of liabilities are overwhelmingly contained within China. It owes money to onshore banks and bondholders and guarantees some wealth management products. On offshore markets, it has about $20bn of debt outstanding.

It also owes money to suppliers and contractors, many of whom have taken legal action against the developer over unpaid bills.

Evergrande did not immediately respond to a request for comment. But as recently as September 13, it said that “recent online remarks about Evergrande’s bankruptcy and reorganisation are completely untrue”. This month, Hui appeared on social media signing pledges to deliver on projects.

What would a restructuring look like?

A restructuring process would probably seek to avoid a liquidation and keep the core real estate development operations running while selling non-core assets to minimise losses for creditors.

Rating agency S&P has said that an Evergrande default was “likely”, with the company due to pay interest on the dollar bonds on Thursday, and that Beijing would seek an “orderly debt restructuring that maximises the value of its substantial assets”.

Ron Thompson, an expert in restructuring at Alvarez & Marsal, said a creditor committee would typically be formed, in which various creditors would make decisions through a majority vote.

China Fortune Land Development, the Hebei-based developer that defaulted in February, for instance, has a creditor committee run by Ping An, China’s biggest insurer, which took a $3.2bn hit from the missed payment.

If creditors start bankruptcy proceedings against Evergrande, they will first have to persuade a court to accept the order. The company will then have six months to produce a reorganisation plan under Chinese law, a deadline that can be extended an additional three months. 

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However, a critical question facing Beijing and Evergrande’s creditors is whether there is enough time to “orchestrate” a pre-packaged restructuring, said Ian Chapman, a partner at Allen & Overy’s restructuring and recovery group in Hong Kong.

The ability to keep its construction projects running is important not only for Evergrande’s survival but also for homebuyers who have prepaid for apartments yet to be built. 

Wei He at Gavekal Dragonomics suggested that completing these projects would be Beijing’s biggest priority. “The simplest way to do that is for other developers to take over the projects and finish construction and use the proceeds of further apartment sales to cover debts,” he said.

How might the government get involved?

As retail investors descended on Evergrande’s headquarters in Shenzhen last week to demand refunds on their investments, eye-catching images of their fury rippled across Chinese social media.

While the central government is eager to limit any further social disruption, S&P did not expect it would provide any direct support for Evergrande “unless systemic stability is at risk”. The rating agency said intervention would undermine the authorities’ campaign, launched last year, to reduce debts at big developers.

Thompson at Alvarez & Marsal suggested that Beijing’s focus in such situations would be “individuals first”.

Local governments are closely connected to property developers, who they rely on for income from land sales as well as economic activity. An Evergrande executive at its wealth management division told the Financial Times that the company had been submitting restructuring plans to the central government since February, but none had been accepted. 

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Evergrande executives have said that one “last resort” was for local governments and big state-owned developers to take over the group’s operations on a “region-by-region basis”.

Jack Rodman, a restructuring expert who has worked with Chinese asset management companies as an auditor, agreed that a regional approach was the “most likely scenario”.

Who would lose out?

International bond markets are pricing in severe losses on Evergrande debt, with bonds maturing next year trading at less than 30 cents on the dollar.

But losses for investors would depend on the price at which they bought. A UBS note sent to clients last week explaining why its funds continued to hold the bonds suggested that Evergrande’s debt was “trading at or below typical historical recovery values”.

In the past, offshore bondholders have been hit hard by failures at companies such as Peking University Founder Group. An S&P analysis of the court restructurings of almost 50 defaulters in China showed that the average cash recovery rate for unsecured debtors was 23.7 per cent.

The deeper question is what a high-profile restructuring would mean for consumer confidence in an economy in which real estate directly and indirectly accounts for almost 28 per cent of activity.

“The real estate tightening needs to be relaxed,” the Evergrande executive said, “or the broader economy will go down”.



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